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Critiquing SEBI’s Disclosure Requirements: An Unforeseen Clash of Two Complementary Laws

The authors are Priyansh Sharma and Nishita Choudhary, fourth year students at Institute of Law, Nirma University.


Introduction


Modern-day corporations couldn't afford to neglect the rights granted to the smallest subscribers of their share capital i.e., Minority shareholders. In the aftermath of the Tata-Mistry fiasco which made the whole world realize the malicious dominance a majority can possess over a minority, companies should adopt an "inclusive" approach towards its shareholders. However, in reality, there's no major difference between the status quo ante before this case and after it in the realm of minority rights.


In the Indian context, a comprehensive legislation namely; the Companies Act, 2013 (“Act”) provides for the rights of minorities, and due to an evolving jurisprudence in this sector, regulatory bodies like SEBI extended this initiative to draft several regulations in consonance with the former. In 2015, SEBI acknowledged the need for transparent financial disclosures to foster corporate governance in a listed entity when it rolled out the Listing Obligations and Disclosure Requirements ("LODR").


This article delves into the inconsistencies between the recently amended SEBI's LODR and Companies Act which exists due to lackluster drafting of Regulation 31B in the former. The authors would be arguing that despite the positive intent, the myopic actions of drafters can lead to inevitable conundrums.


A Bitter Saga of Consent and Approval: Implications of this Cold War?


There's a distinction between de jure and de facto rights of shareholders in the context of a company. If a shareholder or a group of shareholders subscribes more than 50% of the capital of an entity, then, ipso facto, he/it will enjoy 'control' over that entity (inferred from the provisions of the Act). While drawing a line of demarcation, we must distinguish between rights conferred upon shareholders by the virtue of the Act i.e. De Jure, and those conferred by contracts i.e., De Facto. Special rights come under the ambit of both the above-mentioned categories and while granting the same, these must be specified in the Articles of the company. It is conspicuous that special rights are indispensable for minority shareholders in some situations, the most prominent example could be Affirmative Voting Rights in the context of Mergers and Acquisitions.


On the flip side, SEBI has provided a countermeasure to avoid potential abuse of special rights possessed by shareholders. Regulation 31B of LODR mandates a special right holder to seek confidence from fellow shareholders through a special resolution and get periodic approval to continue enjoying the said special right. The objective behind introducing such a provision is palpable and it is to prevent minority abuse at the pleasure of majority shareholders, for the threshold to grant special rights is just striking a consensus amongst those shareholders whose voting power is at least 75% and therefore the said procedure can be exploited according to their whims and fancies.


As noted above, special rights must be recorded in the Articles; a possible conflict could arise when such rights can potentially bypass their restrictions enshrined in SEBI regulations. In the Companies Act, provisions about entrenchment could be perceived as accommodative for minority shareholders as it can protect these shareholders from unjust infringement of special rights granted to them. It is noteworthy that the threshold for obtaining a special right and entrenching it is the same, however once the said right is entrenched in the Articles; alteration of them would be an uphill battle. With the introduction of Regulation 31B, special rights will be approved by shareholders periodically, however if such rights are entrenched, then these could become immune from the said shareholders’ approval.


With a multitude of legislations existing currently, the frequency of 'prevail-override' deadlocks between laws is also increasing. Alteration of entrenched provisions could be performed in any way subject to a condition namely; more restrictive than a special resolution. How can one attain harmony in a situation where the fate of special rights is not subject to a special resolution under Regulation 31B but a consent requirement of the shareholder to whom the rights have been granted and entrenched thereon? Will the articles be able to assume supremacy in such scenarios? Does this signify that the principles of corporate governance envisaged in LODR would be compromised?


Seeking Harmony between the Provisions


It can be argued that entrenchment rights would come under the ambit of special rights and the former must be in accordance with the limitations stipulated in Regulation 31B. The rationale behind such contention is comprehensible; as the threshold for incorporating these in the Articles is the same. However, it must be noted that if these provisions are perceived as equipollent then it will contradict the cognition of legislature which distinguished both by making the process of altering entrenched rights relatively more stringent.


The drafters of the SEBI Act were well aware of the potential conflicts that could arise between it and other laws, and consequently, they had inserted a harmonizing provision in the act. Section 32 of the SEBI Act has restricted it to act as an additional legislation rather than being a derogatory one. On the other side, the Companies Act is the primary legislation governing the operations of a company, with some provisions having an indirect overlapping effect with the provisions of SEBI regulations. It is to be noted that purposive interpretation could be utilized for harmonizing tussles between statutes. After perusing Section 5 of the Act and the Principles governing Disclosure requirements in the SEBI’s LODR, it can be observed that the intent of both the conflicting provisions in this paper is 'minority protection', which suggests that the questions relating to the 'overriding effect' between these two should not arise in the first instance. In crux, if prima facie, it looks like one of them is given precedence over the other, it should not be construed as erroneous but rather synergetic.


Suggesting a Model Framework: Inculcating an Inclusive Approach


Firstly, the root cause for these inconsistencies is loose drafting which is a result of the parochial conduct of the drafters. It is astonishing to witness that the LODR has been amended four times since this regulation was inserted into it; nevertheless, the stakeholders haven't posed any concerns yet.


Secondly, to resolve and subsequently harmonize both the provisions; amendments are inevitable. We are proposing a few amendments that could cure the infirmities from which the status quo is vulnerable. The approach towards minority should be revamped and the only 'exclusion' this class should be subject to is; an exemption under the said regulation. The provision should be amended to include a proviso that shareholders having less than or equal to 10% voting power are excluded (similar to the concept of ‘dissenting shareholder’ provided in Section 235 of the Act).The idea behind such relaxation is reasonable and if one contemplates it, the confidence that the minority is receiving could shatter like brittle bones in a short period. It would be cumbersome for minority shareholders to maintain a favorable position consistently and thus, their special rights can be easily curtailed by exploiting the regulation. This concludes the aspect of the minority with a suggestion to respect their entrenched special rights for fulfilling the principle of minority protection.


In regards to the special rights accorded to majority shareholders, it can be problematic in numerous instances because granting more power to a group already possessing 'control' can be devastating. Taming the bull is necessary to keep it disciplined and prevent mishaps; similarly, we think that the approval requirement stipulated in Regulation 31B should be mandatorily applied to the majority shareholders. One must ponder that the threshold of a special resolution can be easily bypassed if the rights holder possesses exorbitant voting power. It can be observed that preventing such regulatory arbitrage is extremely arduous because this is the common modus operandi for companies everywhere. A reformative procedure for resolutions is suggested by us to break the shackles of abusive conduct by the majority. The rights holder(s) having up to 75% voting power should be subject to a special resolution for getting approval for their special rights, however, if the concentration of power breaches this cap; then the notion of a 'super majority' with a threshold of 95% can be contemplated upon.


In exceptional cases, where the majority unfairly entrench their special rights, the concept of 'minority resolutions' can be imagined. The fundamental tenets of natural justice will be fostered in such resolutions, as the most vulnerable class of shareholders would be the minority if the controlling shareholders attain such draconian powers. This signifies that preserving the legislative intent requires 'out-of-the-box' tactics to be implemented, and therefore this "modified Regulation 31B" should be respected in such a state of affairs.


Conclusion


It is imperative for the legislative wing to consistently analyze the shortcomings in their existing legal instruments and therefore a rectifying measure is incorporated while drafting and enacting a new legislation i.e., amendment. We believe that while solving such riddles, one must be comfortable with not getting an objective answer; instead eradicating the origins of these uncertainties should be welcomed. SEBI should reassess the LODR and fill the grey area which is discussed above. The loopholes must be rectified to avoid the hostile manoeuvres of majority shareholders.

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